Dr Sapnoti Eswar writes for The CFO

Dr Sapnoti Eswar, Senior Lecturer in the Department of Finance at the University of St Andrews Business School, has written for The CFO on why foreign exchange hedging should be treated as an innovation decision rather than a simple earnings shield.

In the article, she argues that the instruments finance leaders use to smooth quarterly earnings can also fund a company’s next decade of products. Drawing on research conducted with Dr Lora Dimitrova of the University of Exeter Business School, published in Research Policy, she finds that firms which hedged their currency exposure went on to produce around 12 per cent more patents than comparable firms that did not.

She explains that the mechanism is cash flow. Research and development is the most exposed line in any budget because it is discretionary and slow to deliver returns, which makes it an obvious target for cuts when a currency move opens a gap in a given quarter. By capping that downside, hedging removes the shock as a reason to raid the innovation budget.

The benefit is strongest among smaller, research-intensive firms that find it difficult or expensive to raise equity, for which stable cash flow is a precondition for investing at all. The additional innovation, she notes, was largely incremental, taking the form of steady improvement to existing products rather than radical departures into the unknown.

Read the full article: Why FX hedging is an innovation decision, not just an earnings shield in The CFO.